Technology is not enough for productivity that matters
Dani Rodrik, professor of international political economy at Harvard Kennedy School, is president of the International Economic Association and the author of ‘Straight Talk on Trade: Ideas for a Sane World Economy’ – extracts from his views follow: “Scientific and technological innovation might be necessary for the productivity growth that enriches societies, but it is not sufficient – without the right kind of complementary policies, technological progress might not lead to sustainably rising living standards and could even set a country back” – hopefully, many more of his learned colleagues will start to sing the same tune
Economists have long argued that productivity is the foundation of prosperity. The only way a country can
increase its standard of living sustainably is to produce more goods and services with fewer resources. Since the Industrial Revolution, this has been achieved through innovation, which is why productivity has become synonymous, in the public imagination, with technological progress and research and development.
Our intuition about how innovation promotes productivity is shaped by everyday experience in business. Firms that adopt new technologies tend to become more productive, allowing them to out-compete technological laggards.
But a productive society is not the same as a productive firm. Something that promotes productivity in a business might not work, or might even backfire, at the level of a whole country or economy. Whereas firms have the luxury of focusing on the productivity of only those resources they choose to employ, a society needs to enhance the productivity of all of its people.
But many economists (and others) have failed to appreciate this distinction, owing to the assumption that technological progress will eventually trickle down to everyone, even if its immediate benefits accrue only to a small group of firms and investors. However, whilst the Industrial Revolution inaugurated the period of modern economic growth, it did not produce advances in well-being for most ordinary workers for the better part of a century.
Worse, the conventional narrative might have become even less true with the most recent wave of technological advances. New technologies can fail to lift all boats because their benefits can be overwhelmingly captured by a small group of players, be it a few firms or narrow segments of the workforce.
One culprit is inappropriate institutions and regulations, which skew bargaining power in the economy or restrict entry by outsiders to modern sectors. Another is the nature of technology itself: innovation often empowers only specific groups, such as highly skilled workers and professionals.
Consider one of the paradoxes of
the hyper-globalisation era. After the 1990s, as trade costs fell and manufacturing production spread around the world, many firms in low- and middle-income countries became integrated into global supply chains and adopted state-of-the-art production techniques. As a result, these firms’ productivity increased by leaps and bounds, yet the productivity of the economies in which they were domiciled stagnated in many cases or even regressed.
Mexico provides a startling case study since it was once a poster child for hyper-globalisation. Thanks to the government’s liberalising reforms in the 1980s and the North American Free Trade Agreementin the 1990s, Mexico experienced a boom in manufactured exports and inward foreign direct investment. Yet, the result was a spectacular failure where it really mattered. Along with many others in Latin America, Mexico experienced negative total factor productivity growth in subsequent decades.
People buy and sell at a local market in Mexico City on June 23.
The Mexican peso has appreciated by 13.45% against the US dollar in 2023. This has led to people receiving money from the United States obtaining fewer pesos when withdrawing it in Mexico because of the strength of the local currency. While it benefits importers, this situation affects 4.6 million households in Mexico that depend on remittances as their main source of foreign exchange. Photo: AFP
As a recent analysis by the economists Oscar Fentanes and Santiago Levy demonstrates, Mexican manufacturing did become more productive as it was forced to compete globally. While less productive firms that failed to adapt eventually shut down, many remaining firms adopted new technologies and became more productive.
The problem was twofold. First, manufacturing firms – especially formal ones – shrank in terms of employment, absorbing an ever-smaller share of the economy’s labour force. Then the rest of the economy, which was dominated by small, informal firms, became less productive. The upshot was that productivity gains in the shrinking globally oriented manufacturing sector were more than offset by the poor performance in other activities, mostly informal services.
Fentanes and Levy attribute these consequences to Mexican labour and social insurance regulations, which they claim encouraged informality and hampered the growth of formal-sector firms. Yet one can find the same pattern of productivity polarisation in many other Latin American economies, as well as in sub-Saharan countries. (Question – Why does no expert economist ever seem to use the same broad argument to explain why Japan always comes out bottom of the official G7 productivity league table? Indeed, most casually overlook it when commenting on the UK’s sclerotic performance)
An alternative explanation concerns the changing nature of
manufacturing technology itself. So great are the skill and capital requirements of integrating into global value chains that countries poorly endowed with these resources face sharply rising cost curves, preventing their firms from expanding and absorbing much labour. Workers flocking to the cities from the countryside have little choice but to crowd into low-productivity petty services.
Whatever the underlying cause, this issue exemplifies why government strategies to boost productivity can miss the mark. Whether it comes in the form of plugging into global value chains, subsidising research and development or investment tax credits, conventional policies often target the wrong problem.
In many cases, the binding constraint is not a lack of innovation in the most advanced firms but rather the large productive gaps between them and the rest of the economy. Raising the bottom – by providing training, public inputs and business services to smaller, service-oriented firms – can be more effective than lifting the top.
